'My R&D Is Bigger than Yours': Is R&D or M&A a Smarter Investment?

Ann All

The rivalry between HP and IBM took an interesting turn with the publication of an interview with IBM CEO Sam Palmisano in which Palmisano stressed the importance of research-and-development spending, essentially boasting, "My R&D budget is bigger than yours." (IT Business Edge's Rob Enderle wrote about that, too.)

 

Noting that HP "used to be a very inventive company," Palmisano said it has been forced to make costly acquisitions because on Hurd's watch it sliced its internal research-and-development budget to the bone. According to The Wall Street Journal article in which Pamisano is quoted, HP's R&D budget was 2.5 percent of the company's revenue in its last fiscal year, down from 4 percent of revenue when Hurd came on board in 2005. In contrast, IBM's R&D budget has remained pretty steady at 6 percent of revenue.

 

I wrote about the drop in HP's spending on R&D last month, comparing it to Dell, which took a similarly shortsighted approach to internal R&D. Perhaps, not coincidentally HP and Dell just engaged in a high-stakes bidding war over virtual storage specialist 3PAR, one that resulted in HP paying a price that many financial analysts consider too high (to the tune of perhaps a billion bucks, according to a CRN piece). HP paid $2.4 billion or $33 a share for 3PAR earlier this month, a price more than three times 3PAR's closing stock price of $9.65. Dell first offered to pay $18 a share.

 

HP isn't alone in its reduction of R&D spending. A Reuters story about China's increase in patent applications notes many other companies cut their R&D budgets during the recession. While innovation spending dropped 20.4 percent at HP, it went down even more at automaker General Motors (24.5 percent) and cell phone manufacturer Motorola (22.5 percent). Other companies cutting R&D: Toyota (19.8 percent), Honda (17.7 percent), Caterpillar (17.8 percent) and Procter & Gamble (7.6 percent).

 

Yet it's not really clear whether increases in R&D spending result in increases in profits. A reader called RVGypsy, commenting on a SeekingAlpha post about HP, wrote:

... In many cases the most innovative work and products come from small companies with a strong entrepreneurial culture. As companies get larger it seems to be increasingly difficult to maintain a culture that is capable of leading edge innovation. Perhaps it is actually more cost effective for large companies to "purchase innovation" than to develop it internally. Consider all the money wasted by Microsoft on failed products. Consider the success Cisco has achieved through the acquisition of technology. It's easier to quantify the "goodwill" paid in an acquisition than the money wasted on internal R&D.

Booz Allen Hamilton research published late last year found companies are becoming more results-oriented with their R&D investments, among other things, shifting resources from basic research in favor of emphasizing new product launches.



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